Did Romney put Bain Capital shares in his IRA?

By Felix Salmon

July 16, 2012

Bill Cohan is the latest columnist to wonder how on earth Mitt Romney's retirement account got so incredibly large -- as much as $102 million -- given the limits on the amount of money employees can put in such things each year. "
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Bill Cohan is the latest columnist to wonder how on earth Mitt Romney’s retirement account got so incredibly large — as much as $102 million — given the limits on the amount of money employees can put in such things each year. Nicholas Shaxson asked similar questions in Vanity Fair this month, and both of them cited the work of the WSJ’s Mark Maremont to help explain what might be going on; Cohan might want to update his link, since the Maremont article he links to is not the one with the real juice.

Maremont explains that when Bain bought a company, it wouldn’t just create debt and equity. Instead, there would be debt, equity, which was known as A shares, and then a kind of preferred equity called L shares. As far as the debt holders were concerned, the A and L shares together were the equity holders. And anybody with equity in the company received the same ratio of A shares to L shares. But A shares were much riskier, and had much more upside than L shares: holders of equity in Sealy, for instance, got a total gain of roughly 4X, where the L shares doubled in value and and A shares wound up worth 34 times what they were originally valued at.

So up until now, the theory has been that Mitt Romney pumped his retirement accounts full of A shares, which often had aggressively low valuations when they were first issued. If those valuations turn out to have been unreasonably low, that could create issues in an IRS audit.

But the recent controversy over when exactly Romney left Bain raises another possibility, which is hinted at in a Maremont article from January:

Several estate-planning experts said they know of others with IRAs of more than $100 million, but they are rare. Typically, they said, that occurs when founders of companies invest in their own shares, which then take off.

We now know that Mitt Romney, individually, was the sole shareholder of Bain Capital when he took leave of all day-to-day responsibilities in 1999 to concentrate on running the Salt Lake City Olympics. And he remained the sole shareholder of Bain Capital through 2002. So here’s the thesis, taken directly from Henry Blodget: that Romney filled up his retirement account with shares of Bain Capital itself, rather than shares in its funds, or in its portfolio companies.

This would also help explain why it took Romney three years to disentangle himself from Bain Capital:

Romney legally remained the CEO and sole owner of Bain Capital until 2002, Conard added, because he was intensively negotiating his exit deal with the partners at the firm. Conard summed up Romney’s position this way: “‘I created an incredibly valuable firm that’s making all you guys rich. You owe me.’ That’s the negotiation”.

Blodget has some very good questions about how Romney managed to set things up so that he was the sole owner of the company: one would imagine that other Bain Capital partners would also have had an ownership stake, not to mention Bain Consulting. But it seems that Bain Capital was a Romney entity, and that he then just handed out fees and carry to various stakeholders, while retaining all of the equity in Bain Capital for himself. When he left, then, he wasn’t just retiring from Bain Capital, he was actually selling the company to its partners. And you can see how that negotiation might have taken a while, given that those partners were picked precisely for their skill in buying companies for a low price.

What’s more, Romney would have had every incentive to keep the official valuation of Bain Capital low for many years, since the lower Bain Capital was worth, the more of it he could put into his retirement accounts every year. Again, the IRS might well be interested in the valuation techniques Romney used for the purposes of his retirement account contributions. And then, of course, suddenly, when Romney left Bain, he would have switched from minimizing Bain Capital’s official value to maximizing it.

I wouldn’t be at all surprised were we to learn that a huge amount of the gain in Romney’s retirement accounts came in 2002, when he finally sold Bain Capital back to its partners. Of course, Romney doesn’t seem remotely inclined to tell us. But if he started Bain Capital from scratch, and put a bunch of the company into his retirement account, and it’s now worth some ten-digit sum, then maybe it makes sense that his retirement account now is ridiculously enormous.

Update: My colleague Lynnley Browning reminds me that she covered this issue in January as well, and had her own theory:

Romney may have made use of an Internal Revenue Service loophole that allows investors to undervalue interests in investment partnerships when first putting them into an IRA…

An investor could even set an initial value for a partnership interest at zero dollars, because under tax regulations an interest in a partnership represents future income, not current value.

This seems conceptually extremely dubious to me: all securities, after all, represent future income. But if Romney had an aggressive tax lawyer, anything is possible.